The historical relationship between U.S. Treasury and equity market performance is significant for investors trying to build balanced and diversified portfolios. In this week’s chart, we examine correlation, which measures how two variables fluctuate together. Positive correlation means that variables move in the same direction, while negative correlation indicates that variables move in opposite directions. Stock-bond correlation has varied over time, but has been predominantly negative since 2000. Negative or lowly correlated assets within a portfolio reduce risk and volatility, as losses in one asset class are offset by gains in another.
Stock-bond correlation was mostly positive from the early 1980s until 2000, as both stocks and bonds were in the midst of extended bull markets. Even in this environment, bonds offered valuable diversification when equity markets were in distress (e.g., 1987 stock market crash, 1998 Long-Term Capital Management crisis).
While bonds have offered reliable portfolio diversification to offset equity risk since 2000, investors reaped the greatest benefits of this diversification within their portfolios when they needed it most. Stock-bond correlation dipped below -0.5 (indicating more hedging power for bonds) during the 2000-2002 tech bubble burst, 2007-2008 financial crisis and 2011-2012 European debt crisis.
Key Takeaway
The proliferation of negative yields across the globe has threatened the valuable diversification that high quality bonds have historically offered investors. Market forces are less likely to drive bond valuations as central bank buying propels sovereign bond yields deeper into negative territory. Swiss 10-year government yields at -1.0% are most likely a hedge only against capital preservation for long-term investors. I expect the Federal Reserve will not follow the questionable interest rate experiment in Europe and Japan, but rather help maintain Treasury bonds as an efficient part of portfolio asset allocation.
The material provided here is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.
This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management. This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.
Opinions and statements of financial market trends that are based on current market conditions constitute judgment of the author and are subject to change without notice. The information and opinions contained in this material are derived from sources deemed to be reliable but should not be assumed to be accurate or complete. Statements that reflect projections or expectations of future financial or economic performance of the markets may be considered forward-looking statements. Actual results may differ significantly. Any forecasts contained in this material are based on various estimates and assumptions, and there can be no assurance that such estimates or assumptions will prove accurate.
Investing involves risk, including possible loss of principal. Past performance is no guarantee of future results. All information referenced in preparation of this material has been obtained from sources believed to be reliable, but accuracy and completeness are not guaranteed. There is no representation or warranty as to the accuracy of the information and Penn Mutual Asset Management shall have no liability for decisions based upon such information.
High-Yield bonds are subject to greater fluctuations in value and risk of loss of income and principal. Investing in higher yielding, lower rated corporate bonds have a greater risk of price fluctuations and loss of principal and income than U.S. Treasury bonds and bills. Government securities offer a higher degree of safety and are guaranteed as to the timely payment of principal and interest if held to maturity.
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